Value to EBITDA

Back when I was discussing the Kraft/Cadbury acquisition in my entries in this blog, I spoke -- as the interested parties there were speaking -- of the P/E ratio, historically an important metric for stock pickers, investors, acquirers, executives who are in part compensated in equity, and gurus.

I believe the gist of that discussion was that over time, the "E" in P/E has acquierd a specific meaning, reflected in the more elaborate acronym EBITDA (earnings before interest, taxation, depreciation and amortization.)

Now it is time to return to the subject to mention that the P part of the P/E ration is in the process of a more radical redefinition. It is not stock price but "enterprise value" that figures in the emerging metric. Here's a discussion from the website of the Stern School of Business at New York University. The "enterprise value" is defined as the combined market value of all securities issued by the enterprise. Why? Because this allows for apples-to-apples comparisons. Different firms will have different balances of debt to equity, i.e. bonds to stock, and these differences would skew price-to-earnings.

Does this help in, say, the discussion of an impending acquisition? Presumably acquirers would look for a low enterprise multiple, because they are going to be buying up that stock and becoming responsible for the payments on those bonds -- they want a sizeable earnings stream in return. If a P/E or P/EBITDA multiple is used instead, the responsibility for the target company's bonds falls out of the picture, or never gets into it.

You can see here how "Seeking Alpha" applied the idea, four years ago.